Tap into Providence's massive exploration upside potential

Over a year has passed since the first well, Barryroe, successfully appraised a previous discovery that is now thought to contain more than a billion barrels of oil - triple the previous estimate - and forms the cornerstone of Providence's asset portfolio. Results from a second well, the Dunquin exploration well in the Irish Atlantic margin, are expected in about three months' time and seismic data suggests it has the potential to be a gas-condensate accumulation of world-class dimensions.

The mid-case resource target is 1.7bn barrels of oil equivalent (boe), containing 8.4 trillion cubic feet of gas (TCF) and 316m boe of recoverable light oil or condensate. The scale of Dunquin hasn't escaped the attention of the majors, nor should it escape that of readers. Besides ExxonMobil, Providence's partners on the well include Italian and Spanish oil giants Eni and Repsol, with Providence retaining a 16 per cent stake.

Granted, the exploration risks involved are significant. The well's chance of success is estimated at just one in six by operator Exxon. Yet should it find hydrocarbons in commercial quantities, Dunquin could be worth up to 1,800p a share to Providence once the project is derisked, according to the estimates by broker Jefferies. While the project would probably take some years to fully derisk, that's nearly triple Providence's current share price

What's more, the share price is strongly underpinned by the value of Barryroe, which means a negative well result shouldn't prove catastrophic. Even after discounting significantly for uncertainties surrounding project development and future farm-down dilution, Barryroe is still worth between 681p and 870p a share, according to broker Oriel Securities, which applies a 63 per cent cumulative discount.

So why do Providence's shares, currently trading for 615p apiece, not fully reflect that? The short answer is the market doesn't think Providence will be able to secure a partner for Barryroe to pay for its development - or secure one on favourable terms. However, the company recently opened up a data room for potential farm-in partners and says it has "already received significant international industry interest" in the project. One concern is that Providence did not complete an extended well test at Barryroe last year and potential partners may not be willing to pay top-dollar in case there are pressure issues or the reservoir is compartmentalised, something that has happened before in the basin.

Nevertheless, we think the market is overpricing these risks and essentially giving investors free exposure to Providence's high-impact exploration programme this year. Along with Dunquin, the Irish explorer plans to drill the Spanish Point appraisal well in the second half of 2013 which, if successful, Jefferies believes could add a further 213p a share once fully derisked. Moreover, as an appraisal well, Spanish Point boasts much greater odds of success than a typical exploration well of around one in two.

There's also the enormous, near-shore Dalkey Island prospect in Ireland's Kish Bank, which Jefferies says could deliver further upside of 1,100p a share, although the likely need to find external financing would probably dilute this as it was commercialised. Regulatory matters have made Providence and major partner Petronas push back drilling of the promising target until late 2013 or early 2014, and a firm drill date has yet to be set. Providence is fully funded to cover its liabilities for the next three wells, as much of the costs are capped or carried. Oriel estimates that net cash at the end of March stood at $52m (£33.5m).